State of the Start-up Economy (U.S.)

Entrepreneurship is neither a science nor an art. It is a practice.
~ Peter F. Drucker

State of the Start-up Economy (U.S.)

If the state of the start-up economy in the United States is measured in terms of temperature in late 2012, it is tepid. It is perhaps warming a bit from 2008 to 2011 levels, but still lagging in most measures compared to the last forty years.

New business creation is the simplest measure of start-up and entrepreneurial activity, and most measures of this activity are low relative to the past. Census Bureau Business Dynamics Statistics briefing published by the Kauffman Foundation show that the rate of new business formation has fallen to between 7 percent and 8 percent (as a portion of all companies), down significantly from the rate of 12 percent to 13 percent in the 1980s.

Businesses less than five years in existence now represent 35 percent of all companies in the U.S., down from the 50 percent they represented thirty years ago. This decrease in number of new firms is accompanied by a decrease in the share of employment at those young firms, down from 20 percent in the past to 12 percent today.

The most recent Kauffman/LegalZoom Startup Confidence Index (October) showed a small indication of improvement in start-up entrepreneur confidence, though caution was also apparent. While a a majority of start-up business owners do not believe the economy will grow in the next 12 months, 83 percent are nonetheless confident that their own profits will. However, in a measure of the ultimate expression of their outlook for their businesses, 63 percent of start-up business owners do not plan to hire additional employees in the next year.

The recession starting in 2008 and slow rates of economic growth in the U.S. since that time certainly play a role in reduced start-up business activity, but the rates of start-up and entrepreneurship have trended significantly downward in the U.S. since before that time. There may be emerging signs of increased entrepreneurial activity in the near-term, but nothing that would indicate a return to the type of start-up activity of the past. New business creation as measured by various sources has fallen by more than 100,000 firms per year.

The downward trend in start-up activity in the U.S. is a significant issue if there is to be renewed and sustained economic growth. Think of start-up business activity as a leading indicator of overall economic activity. Start-up firms create the many of the new technologies, services, and business models that fuel the growth in productivity, jobs, and ultimately wealth. Therefore, continued low rates of start-up business formation portends poorly for prospects of longer term economic growth.

Subdued start-up activity compared to historical norms explains part of reason for continued high rates of unemployment. Kauffman Foundation data shows that if not for start-up businesses there would be no net new job growth in the United States since 1977. New businesses are needed to generate new jobs that take the place of those eliminated by older firms as well as create growth for entry of new people into the workforce.

So why the grim picture of start-up business activity in the U.S.? Has something fundamental changed in the American character? Has the frontier mentality that has driven generations to try, fail, and try again in business disappeared? Has something in the culture that defines opening a new business as the ‘American Dream’ changed?

In my view nothing has permanently changed to leave the U.S. at lower rates of start-up business activity. Some things have changed, however, that impact the incentive to create start-up businesses. Until these incentives change, it seems unlikely that start-up business activity will return to or exceed historic norms.

Reduced start-up business activity results at least in part from diminished incentives to invest time and money, driven by a variety of macroeconomic issues.

The near-zero interest rate monetary policy environment in place more or less since 2001 is not friendly to start-up business activity. This environment encourages consumption over saving. Start-up business creation arises from the central ethic of entrepreneurial capitalism, delaying today’s consumption for investing in tomorrow’s opportunity and tomorrow’s productive people and assets.

Near-zero interest rates drive dollars out of saving to consumption and toward investment in assets such as real estate or commodities. It is perplexing to watch Federal Reserve and Treasury officials put so much effort into propping up real estate values when the bubble in real estate prices was caused largely by their policies in the first place. They continue to act as though the future of the U.S. economy depends on restoration of bubble-like real estate prices, when these prices effectively represent a misallocation of investment into non-productive assets.

Increased levels of public versus private spending also represents allocation of resources away from private sector new business creation. Trillion dollar annual federal government deficits not only represent a risk to future investment through higher debt obligations, it also represents crowding out of private investment in the near term.

In addition, the price of success appears to be rising, thereby reducing the incentive for creation of new businesses. Unsustainable government spending is creating pressure to raise revenues, so there is an apparent electoral appeal to loading higher tax rates on higher income earners. The problem is that many of those higher income earners are those who will help create start-up businesses. Tax success and we are bound to get less of it.

Most current and future generations of American entrepreneurs will find ways to succeed, much in the manner of their eighteenth, nineteenth, and twentieth century forebears who created new businesses through any number of recessions, bad policies, envious politicians, wars , and natural disasters. However, the issue for restoring and then exceeding historic rates of start-up business activity, and ultimately economic growth, is what happens on the margin.

The incentive for creation of and investment in start-up businesses by entrepreneurs and investors who might not otherwise do so is important. These bonus entrepreneurs push the boundaries of invention, innovation, competition, and life improving events beyond what they would have been without them. They are the difference between creating 500,000 start-up companies annually in the U.S. or 700,000, between 2 percent and 4 percent annual income growth, between 8 percent and 4 percent unemployment, and between a future of limping economic progress and one of unbridled prosperity and potential.